Back in the good 'ole days of budget surpluses (i.e., 2001 and 2003), the Bush administration was concerned that if surpluses grew too large, they would stifle the economy's growth. In an effort to reduce the surpluses, Congress enacted significant tax cuts for all tax brackets that would be effective until the end of 2010.

Given the continually fragile state of the economy and enormous budget deficits, should the tax cuts be extended or should they be permitted to expire? The answer to that question is very complicated and requires a little background information.

Stimulating the Economy

From the most simplistic point of view, most economists advocate that in order to restart the economy, we need to stimulate consumption, which should cause employers to hire additional workers, which should reduce unemployment, which should further stimulate consumption, and so on and so forth. Because of this generally accepted premise, the issue at the heart of the debate surrounding the Bush tax cuts is whether the cuts will efficiently stimulate consumption and aid the economic recovery.

Budget Deficit Concerns

Even if the tax cuts do effectively add to the economic recovery, they will very likely continue to add to the budget deficit over the next 10 years to the tune of $3.7 trillion, according to the nonpartisan Tax Policy Center. Although Republicans may argue that the costs of the tax cuts will be netted out by increases in taxable earnings, there is little evidence to suggest that this will occur, at least in the short-term.

Proposals

Surprisingly, many Democrats and Republicans agree that the tax cuts should be extended, at least temporarily, for 97% of Americans, i.e., all but the top two tax brackets. In terms of income, this means the cuts will be extended for those individuals that make less than $200,000 per year and those families that make less than $250,000.

Republicans argue that the cuts should be extended to all tax brackets because of the tenuous economic recovery and because of a possible "double dip," — a worsening of the economy caused by too little consumption. They argue that increasing the tax rates on the wealthy will discourage business owners from hiring new employees or reinvesting profits in their businesses. A relatively small group of Democrats also support this premise.

Democrats contend that the taxpayers in the top two tax brackets will not allow increases in their tax liabilities to affect personal spending, business spending, or hiring new personnel. They claim that business owners will hire additional employees if it is a good idea, regardless. Democrats also claim that the wealthy are much more likely to simply save their money than spend it, but that those lower-income taxpayers are much more likely to spend the money and increase consumption immediately.

According to the Tax Policy Center, if the tax cuts are allowed to lapse for the top two tax brackets, it will shave $700 billion off the budget deficits over the next 10 years. However, if all the cuts are extended, the majority of that $700 billion will go to the wealthiest 1/10 of 1% of Americans, who earn more than $7 million per year, on average, and will result in an average tax savings of $3 million over a 10-year period for those taxpayers.

Although many Democrats and Republicans do think the tax cuts should be at least partially extended, there are those that think the cuts should be allowed to lapse completely, including former Federal Reserve Chairman Alan Greenspan. During an Interview on NBC's Meet the Press, Greenspan said: "[t]he problem we've gotten into in recent years is spending programs with borrowed money, tax cuts with borrowed money, and at the end of the day, that proves disastrous."

How This Will Affect You

Because this is an election year, members of Congress are loathe to increase taxes on constituents and may not act until after the November elections, at the earliest, and possibly not until next year. If the tax cuts are allowed to expire, taxpayers in most tax brackets will see a 3% to 5% increase in their tax liabilities. The marriage penalty will return, meaning the standard deduction for married couples will be less than the standard deduction for two unmarried people. The child tax credit will be reduced from $1,000 to $500. The long-term capital gains tax will increase from a maximum of 15% to 20%. Qualified dividend plans, which are now taxed at 15%, will be taxed at the same marginal rate as the taxpayer.

What do you think? Do you support allowing the cuts to expire? Why or why not?

This is a guest post by Steve Cook. Steve is an associate with a Phoenix, AZ-area law firm that specializes in taxation. He is also a bit of an economics, web design, and software engineering nerd. Read more articles from Steve's firm:

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Valerie M #1

The fuss is if they are going to give or keep a tax cut, they should see it as a resulting smaller federal budget... not something we owe the government in the future (a deficit). If they're going to package it as a "gift" or as "help," then give it as a true gift without strings attached. I'm not sure why this evades politicians.

I see no mention of how out of control the spending has become in Washington. There's no reason we should be running a deficit. It's absolutely irresponsible of our elected officials to misuse our tax money, and that includes spending more than they have. We need to reduce spending to rein in the deficit, not raise taxes. I also think it's disingenuous for Obama to be such a deficit hawk when he is the one who raised the deficit and debt to unprecedented levels.

Alan Greenspan is not the brightest person. His quote "tax cuts with borrowed money" proves this. The federal government does not borrow money to cut taxes. The federal government simply takes a pay cut when it cuts taxes.

The federal government is borrowing money to pay for entitlement programs. The solution is simple. Give the people back their money, and cut spending.

I'm assuming that Greenspan was (over)simplifying the situation; if we have tax cuts that aren't accompanied by corresponding spending cuts, you end having to borrow money to meet the spending needs, thus, 'cut taxes with borrowed money'. As long as the government refuses to get its spending under the money it takes via taxes, borrowing money is going to continue to be a problem.

Steve, Why do small business people taking home $250-$500k taxable income need to be singled out for "help"? Keep in mind that personal income rates apply to your income after deductions and your income from a business is not equal to your business revenue. Giving tax breaks on personal income to business owners does not directly help the businesses in any way but instead just lets those people with very high salaries keep more of it after taxes.

Jim, that's just plain false. Most small businesses are taxed according to personal tax rates and schedules (as even Democrats will concede), so when you see a $250K income it's total business income - not the take home income of the owner. What has to come out of that total revenue is all the business expenses (employee benefits and salary, machinery, systems and communications, office rent, etc etc). Oh, and taxes. What's leftover is what the business owner might get to take as a distribution or salary.

Increasing these "personal" tax rates effectively increases the taxes that small business pay. That's why so many people are worried about the tax increases causing more layoffs. There's only so much revenue to go around, and with many businesses not able to borrow and not seeing their sales increase, a tax increase might be just what prompts them to lay off some folks - or even shut their doors.

Small business owners are ONLY taxed on their PROFITS. When you fill out the 1040 and include business income you file schedule C. Schedule C counts your revenue and then subtracts the expenses to find the profit. So small business owners making $250-$500k are making PROFIT of $250-$500k. That is AFTER the expenses of the business are deducted. That $250-$500k is pure take home profit and taxing that at a higher rate will not impact the solvency or ability of the business to hire people or function at all since this is PROFIT taken out of the business by the owner for their own income.

Example: I'm a doctor and I bill my patients for $800k in bills. I then pay my nurses and other employees $250k and pay $100k in rent I have other business expenses of $100k. I then file my 1040. I fill out schedule C and list revenue of $800k less expensees of $450k. The profit is $350k which goes down on my 1040 line 12 as my business income. I'm not taxed on $800k, I'm instead taxed on $350k which is my PROFIT. If I have to pay 3% more income tax on that profit, that has no impact on the $250k that I'm paying the receptionist and nurses or the other business expenses. It has an impact on how much I put in my pocket after all expenses are paid.

Nick #10

If Obama is a socialist for wanting to raise the highest tax rate from 36 to 39 percent then I guess Eisenhower was Josef Stalin (highest tax rate was 91 percent during his term) and Nixon was V.I. Lenin (highest tax rate was 70 percent during his term).

Democrats contend that the taxpayers in the top two tax brackets will not allow increases in their tax liabilities to affect personal spending, business spending, or hiring new personnel.

This makes no sense. If your tax liability goes UP and your income stays the SAME then there is no possible way that either your personal spending or business spending will have to go DOWN.

In my experience as a banker, many small business owners cut their own salaries or decline to take bonuses when cash flow gets tight - then they quit investing in new equipment or upgrading technologies. Then only if there is nowhere else to cut and they see no prospect of cash flow picking back up do they lay off employees.

The highest 3% of earners are responsible for a LOT more than 3% of our GDP and consumer spending. Hitting them hits the economy more than most people think when they toss around those "we're only talking about a few people" statistics.